Kisan Vikas Patra vs Gold – Why KVP?

Kisan Vikas Patra (KVP) was re-launched with much fanfare by the finance ministry, with initial reports suggesting the minister promised these would be bearer instruments that could be purchased in cash. The unspoken implication was that it would be as convenient to buy as gold and, hence, become a go-to investment for the black money floating in the domestic economy.

Opposition parties were quick to criticise the instrument, till it became clear that the relatively-relaxed Know Your Customer (KYC) norms were applicable only for investments up to Rs 50,000 and even for that, the only relaxation was that the Permanent Account Number (PAN) was not required but identity and address proof were, even for the minimum investment of Rs 1,000. It was a very different regulatory regime that had earlier allowed issuance of KVPs or Indira Vikas Patras for large cash investment without proper KYC requirement. Now, the government is bound by its obligations on anti-money laundering laws and might not be able to come out with any bearer financial instruments. So, it is very unlikely that black money holders will invest in KVPs instead of gold. Gold is easily available in the grey market for cash payment with no questions asked and as it is widely presumed to give returns in line with inflation, it is expected to protect the value of the investment even though it is no longer as easy to sell back the gold in cash for large values.

The focus on gold as a store for black money has obscured the demand for gold by middle-class Indians who are not hiding unaccounted money but investing their tax-paid money in gold. Many Indians consider it a good investment instrument, which will also come in handy in future for their children’s marriage. This is testified by the popularity of jewellery schemes with retail investors, including women investing properly accounted money (though maybe without their spouse’s knowledge). These consumers have invested in jewellery so that after 10-15 years, they can exchange this jewellery for fresh ones to be purchased on the occasion of their children’s marriage. This kind of investment by regular middle-class consumers will be a reasonably significant part of the 2,400 tonnes of gold estimated to be held by Indian households.

If a part of this hoard can be freed, it will reduce the import of gold to that much extent. The government had introduced a gold deposit scheme 14 years ago for this purpose. The scheme provides for a gold certificate to be issued in lieu of jewellery, with interest and redemption being in gold units. These certificates are also exempt from income tax, capital gains tax and wealth tax. Despite its many attractive features, the scheme has never really taken off for individual consumers because of some basic shortcomings.

First, the minimum quantity is a stiff 500 gm (equivalent to about Rs 15 lakh of jewellery), which effectively cuts off the retail consumer from the scheme. Reducing this minimum limit to, say, 50 gm would bring in a large number of retail consumers. Second, capital gains tax is payable at the time the jewellery is converted into a gold deposit scheme. If a certain threshold amount, say, 100 gm or roughly Rs 3-lakh worth of jewellery, is exempted from capital gains for each individual consumer, it will remove a major irritant for entry into the scheme. The amount of capital gains tax given up will not be significant, given that most jewellery tendered in the scheme tends to be many years old and because of indexing, the effective rate of capital gains tax is not very high. Third, the certificates need to be denominated in a single gram (like most gold exchange-traded fund units) for ease of tracking and partial sale/redemption.

These changes should enable the government to bring out a significant part of the jewellery hoard with the regular Indian middle class consumers, unlike the current situation where the scheme has basically been used by institutional investors such as temple boards and gold ETFs. Even if the changes are only partly successful, it will still make a dent in the stiff import bill we pay for gold.